Since 1950 the global Gini coefficient for between-country income inequality has stood at about 55, reflecting a twenty five-fold difference in wealth between the richest and poorest countries. A well-known stylized fact underpinning this feature of the world economy is that the real investment rate of wealthy countries such as Norway and the United States is roughly two to three times that of poor countries such as Mali and Kenya. Based on this evidence, the literature seeking to understand international inequality has attributed a key role to differences in physical capital intensity.
The early literature attributes low capital intensity to low savings rates, combined with limited international capital mobility. Low savings rates have been attributed in turn to poor institutions, and policies that result in high effective tax rates on capital income such as high explicit tax rates, high discount rates, and high dependency ratios. Alternatively, low-saving traps have been attributed to subsistence consumption needs. This line of reasoning formed the intellectual foundations for the lending work of institutions such as the World Bank.
A more recent strand of the literature assigns a central role to factors that directly determine the cost of capital. From this perspective, poor countries have low real investment rates because they tax capital goods, erect or endure barriers to trade in capital goods, or grant monopoly rights to domestic capital goods producers. Recent contributions to this literature have been organized around an Eaton Kortum (EK) model wherein capital can grow both through domestic and imported capital formation. Within this framework, trade frictions have been identified as quantitatively important in understanding why standards of living and measured total factor productivity between the richest and poorest countries differ by so much.
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